"Taking the Mystery Out of Mutual Funds"
Remarks by Chairman Arthur Levitt
United States Securities and Exchange Commission
Boston Citizens Seminar
Boston, Massachusetts -- February 25, 1997
It's great to be back in Boston, the birthplace and the heart of
the mutual fund industry. These Citizen Seminars exemplify the
spirit of this city, whose pride, patriotism, and sense of public
duty have so deeply influenced our nation.
Once upon a time, you led a revolution against English
oppression; today I've come here to wage a revolution against
oppressive English.
The British writer W.Somerset Maugham once remarked that "There
are three rules for writing a novel. Unfortunately, no one knows
what they are."
He could just as well have been talking about prospectuses.
On the day after tomorrow, the SEC will consider the most
sweeping revision of mutual fund disclosure in many years. With
all respect to Somerset Maugham, the number of rules involved is
three. But I assure you that's just a coincidence. Both the SEC
and the mutual fund industry have been seeking ways to improve
prospectuses for half a century. These new rules may not
represent the Holy Grail -- but they will make prospectuses
simpler, clearer, more useful, and, we hope, more used.
Signs of the prospectus's disuse are evident everywhere. One
survey by the Investment Company Institute last year found that
only half of fund shareholders consulted a prospectus before
making an investment. Another survey by the SEC and the
Comptroller of the Currency revealed that, although investors
consulted the prospectus more than any other source of
information about a fund, they considered it the fifth-best
source of information -- after employer-provided written
materials, financial publications, family or friends, and
brokers.
This take-or-leave attitude toward the prospectus has even seeped
into popular culture -- like the cartoon that appeared in the
Washington Post the other day. A man and a woman are researching
mutual funds, at a table covered with papers. The man cracks
open a prospectus and says, "You know, I met a guy once who
actually read one of these."
There's no question that an overhaul of the prospectus is long
overdue. The problem is not merely how we write prospectuses,
but how we think about prospectuses. Investors today are
bombarded with information from every quarter. The world has
changed since the Securities Act was passed in 1933, but our
rules about investor information haven't kept pace.
In 1933, only 31 percent of American households had telephones.
Today, 94 percent have telephones -- and 30 percent have
computers that can turn their telephone line into the world's
greatest library of information, the Internet.
Back then, you had a limited number of financial instruments to
choose from: stocks, bonds, and a handful of funds. Today, we
have mutual funds investing in every conceivable instrument,
including collateralized mortgage obligations, futures, options
and other derivatives. I wouldn't be surprised if we soon saw
funds holding the "Bowie Bond," a triple-A rated investment in
the British rock star based on anticipated sales of his records.
In 1933, investors could choose from 32 mutual funds; today, they
have a staggering 6,270 funds to sift through.
The radio was a primary source of information in 1933, but only
63 percent of US households had one -- and by the end of the
decade, they had 847 stations to choose from. Compare that with
99 percent of households today, with more than 10,000 stations
available.
And I haven't even mentioned television, which was in its infancy
during the 1930s. Even a decade later, in 1946, only 8,000 US
households owned a set, and they had access to 30 stations.
Today, 95 million households can tune in to more than 1500
stations, many of which are devoted to conveying financial
information.
No wonder people don't read prospectuses anymore -- if they ever
did. We are the most wired, signaled, cabled, beeped, paged,
plugged-in, on-line, and communicated-to society the world has
ever seen. Years ago, the problem was a lack of information;
today, it is a glut of information. Prospectuses have to work
for investors, if they are to survive in the new world of
information.
As funds, lawyers, and regulators have loaded up the prospectus
with more and more information, the prospectus has strayed from
its primary purpose of helping people decide whether to invest in
a particular fund. Today, many prospectuses, by their very
length and complexity, tend to obscure the essential information
that would help people make investment decisions.
One of the more startling pieces of information to come my way in
almost 4 years as Chairman was a summary of an SEC focus group.
We asked participants what sources of information they used in
deciding whether to invest in a fund. Their answer? Friends,
family, brokers, financial advisers, magazines, newspapers,
financial publications, the Internet, radio, and television.
Only one investor mentioned using a prospectus.
This is not an easy message for people to hear. Many of us find
it hard to accept that the prospectus is not fulfilling its
intended purpose.
This disuse of the prospectus comes at an inauspicious time:
During the 1990s, a long decline in interest rates, a continued
bull market, and a shift from defined-benefit to defined-
contribution pension plans have sparked a mass migration of
investors away from bank accounts, CDS, and other insured
products, and into our stock markets. Investors today have far
more money in mutual funds -- $3 « trillion -- than in
commercial bank deposits -- which total some $2 « trillion.
This huge influx into our securities markets has provided new
opportunities for investors -- and new opportunities for America.
But it's also increased risk -- and it's created confusion and a
greater potential for disappointment among investors who don't
understand their investments.
The fact is, investors are not as informed as they should be.
This is especially troubling because most of these new investors
have experienced only a bull market; I fear that in a downturn,
those who don't understand risk may react precipitously and
carelessly, at great cost to themselves and our markets.
This new generation of investors has provided the impetus for our
improvements in disclosure.
Two and one-half years ago, I announced a major SEC initiative
"aimed at the heart of prospectus-speak." I acknowledged that
the SEC itself was part of the problem, and we committed to
change our ways and support funds if they wrote their
prospectuses in plain English and made them less encyclopedic.
Several funds responded -- they obviously realized that better
communication to investors leads to better understanding by
investors. Indeed, efforts to give new life to the prospectus
struck a chord with investors and inspired some of the changes we
will propose -- off the top of my head, I can think of several
fund companies that have heeded the call to simplify, including
John Hancock, Vanguard, and Gateway, among others.
In addition, eight fund families stepped forward at the SEC's
request to participate in a pilot project for a prospectus
summary we call the Fund Profile -- a description of eleven key
attributes in a standard format, easy to read, and easy to
compare with other funds.
We are now ready to take the best practices and products of our
volunteers, together with the results of our own research into
how we can best improve disclosure, and implement positive change
throughout the mutual fund industry. The three rules to be
considered this week aim to close the circle on this initiative.
Underlying them all is the simple notion that it is not
necessarily the quantity, but the quality of information that is
most important to investors. In our view, prospectuses, whether
long or short, should provide investors with useful, accurate,
and relevant information in language that they can understand.
Let me tell you about each proposal in turn.
Revised registration form
The first rule is the keystone of our entire effort -- it
essentially dismantles the registration form and prospectus
requirements for mutual funds, and rebuilds them in a more
logical way. This initiative attempts to make prospectuses
easier for investors to use and easier for funds to prepare.
The new prospectus would refocus content on what's important to
people in the real world faced with investment decisions. We've
concluded that prospectuses contain too much generic disclosure
of technical, legal, and operational matters common to all funds.
Instead, we will ask for essential information people should know
about that particular fund before investing. The focus will be
on how funds differ, rather than how they are the same. Risk
disclosure will emphasize the risk of the fund's portfolio as a
whole. This is a shift away from the current approach of most
funds, which give laundry lists of detailed, technical
descriptions of the risks of individual securities or other tiny
components of the funds' holdings. This tells an investor little
about how risky the fund itself may be.
We recognize the importance of risk disclosure to investors, and
so we will propose to include a new risk/return summary at the
beginning of all fund prospectuses. It would highlight the
fund's investment objectives and strategies and improve
disclosure by including four items:
* first, a concise narrative description of a fund's overall
risks;
* second, a bar chart reflecting a fund's ten-year returns, which
would illustrate risks by showing how the fund's performance has
changed from year to year;
* third, a table accompanying the bar chart that compares the
fund's performance to that of a broad-based securities market
index; and
* fourth, an improved fee table.
The risk/return summary would ensure that all investors have
concise summaries of key information that they really could use
at the kitchen table to evaluate and compare fund investments.
There's another problem with prospectuses: They are too thick.
Our passion for full disclosure has resulted in fact-bloated
reports, and prospectuses that are more redundant than revealing.
It turns out that more disclosure does not always mean better
disclosure and that -- especially in an environment that
virtually inundates us with data -- too much information can be
as much a curse as too little.
We propose to clear away the clutter by moving information that
is the same for all funds -- such as legal, technical, and
operational matters -- out of the prospectus. This information
does not help a person decide whether to invest. Those investors
who are interested could obtain this information upon request in
a Statement of Additional Information. At the same time, we have
addressed a longstanding concern that an investor who wants
additional information should get it -- promptly. Our rules
would require a three-day response from funds.
On a similar streamlining note, we intend to allow funds to
tailor prospectuses to meet the needs of investors in retirement
plans, by omitting information that is not relevant to plan
participants, such as purchase and sale procedures.
Our proposals would also allow for "one-stop shopping" by
requiring information about a fund's fees and expenses to appear
together in one place in the prospectus. Currently, this
disclosure may be scattered throughout the prospectus and hard to
find.
Finally, we have tried to make it easier for funds to prepare and
file their registration statements, by simplifying the
instructions for preparing prospectuses. We are also eliminating
or updating SEC disclosure positions now found in 35 Guides and
numerous Comment Letters.
Fund names
These measures will change the information we require funds to
give investors. Our second rule, however, will ask funds to live
up to the information they themselves give investors.
We are concerned that certain fund names may inadvertently
mislead investors about a fund's investment objectives and risks.
It's been said that potato-chip makers are subject to stricter
labeling requirements than mutual funds. I don't buy that
argument -- in fact, I think it would be destructive to force
each fund to carry a label, and thereby reduce its investment
options. The fund industry has gotten along just fine for half a
century without such pigeonholing.
But at the same time, it's only fair that if a fund represents
itself as investing in Japanese bonds, it ought to live up to
that label. Our new rule would require a fund with a name
suggesting a focus on a particular type of investment to invest
at least 80 percent of its assets accordingly. This will give
investors greater assurance that the fund's investments will be
consistent with its name. It will also help reduce confusion
when an investor selects a fund for specific investment needs and
asset allocation goals.
Fund Profiles
The third measure we will consider this week is the coming of age
of Fund Profiles, after a successful two-year experiment.
Profiles summarize key fund information, including investment
strategies, risks, performance, and fees -- and they do so in a
concise, standardized format. The profile also includes
information about the fund's investment adviser and portfolio
manager, purchase and redemption procedures, tax implications,
and shareholder services.
The profile proposal will let funds offer investors the option of
relying on a new, summary disclosure document when buying fund
shares. Neither funds nor investors would be required to use a
profile. Nor would the profile replace the prospectus.
If a fund does employ a profile, an investor could either
purchase the fund's shares based on the profile alone, or could
request and review the fund's prospectus and other information
before making an investment decision. All investors would still
receive a prospectus, upon confirmation of a purchase and no
later.
We've made certain enhancements to the Profiles since our pilot
program to improve their risk disclosure. Among them, the
profile will compare a fund's past performance to that of a
comparable broad-based securities market index.
Let me add that the proposal would not limit a fund's use of any
particular medium for disseminating the profile. A fund could
make a profile available on the Internet or by mail, in
newspapers or in other media.
This initiative recognizes the diversity of investors that exists
today and their equally diverse information needs. Our
experience with pilot profiles has shown that investors want more
choices about how they receive information about funds. For many
investors, a profile can be as helpful to the decision making
process as a full prospectus. Some investors may even prefer it.
It makes sense to stress quality in all disclosure documents,
whether long or short. It also makes sense to give investors
more options.
Plain English
There is one other aspect of these rules I want to share with you
before I close. They call for clear communication, and a vital
ingredient of clarity is the use of plain English.
There's no escaping it -- especially with so many people now
investing in the market. If you want to communicate with a broad
segment of society, you must use the vernacular.
This is no new thing under the sun. In the 9th century, the
Emperor Charlemagne ordered sermons to be delivered in the
vernacular. In the 16th century, Martin Luther translated the
Bible into the vernacular.
Our task is far more humble -- the subject we address is not
faith, but finance; and the idiom we reject is not Latin, but
legalese.
It is possible that no document on Earth has committed as many
sins against clear language as the prospectus. The prose trips
off the tongue like peanut butter. Poetry seems to be reserved
for claims about performance, and conciseness for discussions
about fees.
In fairness, much of the arcane language is aimed at legitimate
legal concerns. But the fact remains that disclosure is NOT
disclosure if it doesn't communicate.
The time has come to pierce the shroud of jargon and boilerplate
surrounding the prospectus. It's my aim to have prospectuses
begin to speak a new language -- the English language.
The SEC is not alone in recognizing this problem. I can't tell
you how many times, in the town meetings we've held across
America, investors have stood up and requested, argued, pleaded
with me for documents that are useful and easy to read.
Making disclosure documents more readable is especially important
today, with all the new investors in our markets, and with all
the choices they face. For these people, plain English is not a
novelty, but a necessity.
Plain English does not mean "dumbing down" -- it means presenting
information clearly. The SEC recently compiled a handbook that
features advice from people who have created plain English
documents, with a foreword by Warren Buffett. We've posted it in
draft form on our Web site, and we invite you to comment on and
use it.
We recognize that all of us need to work together to do better at
this. The SEC is hardly in a position to throw stones -- our own
rules and communications are among the reasons why plain English
has not taken root sooner. And if we succeed in improving
investor understanding, the winner will not be any one of us --
it will be the 63 million Americans who invest in mutual funds --
that's 63 million and growing every day.
We have within our grasp a chance to help them -- a chance to
change the way they buy funds, and to ensure their expectations
are realistic -- a chance to make it easier for them to make
comparisons, and easier to get right to the key issues they need
to know before investing. For when all is said and done, that's
what these initiatives are about -- hardworking people reaching
for a better life -- buying that new home, sending the children
to college, taking that much-needed vacation, or enjoying a
decent retirement. People looking to our capital markets as
never before, for financial growth and economic success.
This is the promise of America -- and few industries have brought
that promise within the reach of more people than the mutual fund
industry. Let's build on that trend -- let's strengthen our
markets and strengthen our people -- through better regulation
and clearer communication. Thank you.
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